China Inches Toward Revaluation

littlekracker

Posts : 2928Join date : 2009-06-16Age : 50Location : Bryant Ar

April 12th 2010China Inches Toward Revaluation

The hoopla surrounding the semi-annual release of the Treasury’s currency report has been awkwardly resolved. As a result of Chinese Prime Minister Hu Jintao’s last minute decision to participate in a US conference on nuclear disarmament, the Treasury has agreed to delay the release of the report for an indeterminate period.

While a handful of commentators saw this as a simple quid pro quo, the consensus among most of us is that a revaluation of the Chinese Yuan is now imminent. Technically, the RMB has been rising steadily for the last few months, and in fact, it recently touched a 9-month high against the USD. However, this appreciation has amounted to a mere .3%, certainly not enough to placate critics, many of whom insist that the RMB is undervalued by 25-40%. Probably within the next couple months (and as soon as tomorrow), the RMB peg will probably be lifted by at least 5% against the Dollar, and allowed to appreciate incrementally from there.

On the surface, it looks like President Obama deserves much of the credit for the sudden capitulation by China. From tire tariffs to a meeting with the Dalai Lama, he signaled that he was willing to play hard ball. As Senator Charles Schumer, one of the most vocal critics of China’s forex policy, said recently, “Every administration has thought it could get something done by talking to China. But years of experience have shown that the Chinese will not be moved by words; they only respond to tough action.”

While this game of high-stakes International Poker was being played, there was an internal debate taking place within China. On one side was the Central Bank, frustrated by its inability to conduct monetary policy independent of the currency peg. On the other side was the more powerful Commerce Ministry, which is responsible for representing the interests of Chinese exporters, among others. It appears that the Commerce Ministry has lost the debate, although it isn’t going down without a fight. After economic data showed the first monthly trade deficit ($7+ Billion) in 6 years, a press release argued that, “The continued improvement in our country’s balance of trade has created the conditions for the renminbi’s exchange rate to remain basically stable, case received a boost from the March $7 Billion trade deficit, the first monthly deficit in 6 years.”

China monthly balance of trade 2004 - 2010At this point, analysts have stopped arguing about whether the revaluation is necessary (though this debate has not officially been resolved) and moved on to simply trying to predict the outcome of the internal Chinese negotiations. Some are skeptical:”Based on off-the-record briefing from officials in Beijing, one development that does not appear likely in the short term is any Chinese action to change the currency peg that ties the renminbi to the dollar.” However, this is contradicted by the prevailing view among China-watchers, which is that “Beijing will move on the currency not because they want to placate international pressure on trade flows but because domestic conditions suggest that such a move will be in their own interests.”

This is reflected in futures prices, which are now pricing in a 3% appreciation in the RMB by the end of the year, compared to expectations of a mere 1.5% appreciation in March. What’s harder to gauge (and speculate on) is how other currency pairs will be affected. Some analysts believe that an RMB appreciation will trigger a decline in the Euro, since China’s currency peg had also necessitated tangential purchases of Euros: “The euro will be more vulnerable from the perspective that the People’s Bank of China in the past diversified away from Treasuries to buy euro zone bonds.”

RMB USD December 2010 Futures PricesAsian currencies should also benefit, since a more expensive Yuan will trigger a marginal shift of (speculative) capital to regional competitors, especially those with undervalued currencies. In fact, the Bank of Korea is already on high alert for any “unusual” (code for sudden appreciation of the Won)activity in the forex markets, and has suggested that intervention is always a possibility.

As for me, well, I’m not taking any chances. I just transferred some of my savings from Dollars into Yuan (of course this wouldn’t really make sense if I didn’t live in China). I like to think of it as a rudimentary form of hedging.